"Fixed Income": Introduction to Asset-Backed Securities
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Questions 1:
An investor who owns a mortgage pass-through security is exposed to contraction risk,which is the risk that when interest rates:
A 、decline, the security will effectively have a longer maturity than was anticipated at the time of purchase.
B 、decline, the security will effectively have a shorter maturity than was anticipated at the time of purchase.
C 、rise, the security will effectively have a shorter maturity than was anticipated at the time of purchase.
Questions 2:
How much will the value of a three-year $100 par value coupon bond with annual payments, a coupon rate of 9%, and a discount rate of 7% most likely change if market interest rates immediately increase by 1%?
A 、–2.68
B、 –3.47
C、 –2.40
B is correct. Contraction risk is the risk faced by investors when interest rates fall in that the security will effectively have a shorter maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates.
A is incorrect because contraction risk is the risk faced by investors when interest rates fall in that the security will effectively have a shorter, not longer, maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates.
C is incorrect because contraction risk is the risk faced by investors when interest rates fall, not rise, in that the security will effectively have a shorter maturity than was anticipated at the time of purchase because homeowners can refinance at new, lower interest rates.
【analysis】
B is incorrect because it assumes a year passes before the discount rate increases from 7% to 8% and calculates a new bond value of 101.75.
C is incorrect because it reverses the coupon rate and discount rate in the calculations.
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